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Taking care of mom
Are we eligible for any tax relief since we're selling our house to take care of an ill loved one?
April 29, 2005: 7:42 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

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NEW YORK (CNN/Money) - In order to take better care of my mother-in-law, who is fighting emphysema and alcoholism, my wife and I have decided to sell our townhouse in Virginia and move to Maryland. We have lived in our home less than two years, however, so we are afraid we will have to pay capital gains taxes on the profit when we sell.

We've heard we may be eligible for some relief since we're selling to take care of an ill loved one. Is that true and, if so, what sort of relief might we get?

-- Greg, Ashton, Maryland

It sounds to me as if you may qualify for what the IRS refers to as a "reduced maximum exclusion." Here's the deal.

Normally, house-sale profits of up to $250,000 for individuals and $500,000 for married couples escape capital gains taxes, provided the owner meets two tests -- the ownership test and the use test. During the five-year period that ends with the date of the sale, you must have owned the home at least two years and you must have lived in the home as your main residence for at least two years.

By the way, those two two-year periods don't necessarily have to overlap. For example, if you live in a house as a renter in, say, 2000 and 2001, then buy the house at the beginning of 2002 and then sell it two years later in 2004, you meet both tests.

Similarly, the two years you lived in the house and owned it don't have to be continuous. You can meet both tests if you owned and lived in the home for any 24 full months or 730 days during the five-year period ending with the sale. So if you owned and lived in the home for a year, lived abroad for two years, returned and lived in it another year and then sold the following year, you would qualify for the exclusion.

But people who don't meet the ownership and use test lose the exclusion and must pay tax at the applicable rate for capital gains on any sales profits, unless they qualify for certain exemptions, in which case they may be able to exclude a portion of the profit from taxation.

One of those exclusions applies to people who sell for health reasons. Specifically, the IRS says "if your primary reason for the sale is to obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of disease, illness, or injury of a qualified individual," then you can exclude a portion of the gain from taxes.

Who, you may ask, is a qualified individual? The IRS spells that out too. It can be a parent, grandparent, stepmother, stepfather, child, grandchild, stepchild, adopted child, brother, sister, stepbrother, stepsister, half brother, mother-in-law, father-in-law, brother-in-law, sister-in-law, son-in-law, daughter-in-law, uncle, aunt, nephew, niece or cousin. All in all, pretty inclusive.

How much shelter will you have?

So just how much of the gain can you shelter from the tax man? Basically, you take the number of months you (or you and your spouse, in the case of married couples) lived in the home as your main residence or the number of months you owned the home (whichever is greater) and divide that number by 24 months.

The resulting percentage is the portion of your gain that goes untaxed. So, if you lived in the house for 12 months and owned it six months, you would take the larger number, 12 months, and divide by 24 to get 1/2 or a 50 percent exclusion.

As usual in tax matters, I've got to add a few caveats. Things get more complicated if you sold another home during the previous two years and excluded a portion of the gain for sale. And you can't qualify for this health exemption if, in the words of the IRS, "the sale merely benefits a qualified individual's general health or well-being."

So if I were taking this exemption, I would be sure to document the seriousness of the person's condition and be prepared to show specific ways I've been involved in helping that person deal with that condition.

By the way, that there are other reasons one might qualify for the exemption, including if you sold the home because of a change in your place of employment or because of an unforeseen circumstance such as a natural disaster. I should also add that members of the armed forces, foreign service officers and certain other government services get some leeway in applying the ownership and use test.

Check the details

All the messy little details relating to the exclusion, the exemptions and virtually everything else you need to know about the tax consequences of selling your home can be found in IRS Publication 523: Selling Your Home, which is available at the IRS Web site.

You'll even find a neat little worksheet that will help you calculate the size of your taxable gain after allowing for such things as additions and improvements, not to mention a worksheet for calculating your reduced maximum exclusion if you don't qualify for the full exclusion.

Once you and your wife have gotten all this stuff out of the way, you'll be able to focus on the more important task that prompted your move in the first place.


Walter Updegrave is a senior editor at MONEY Magazine and is the author of "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."  Top of page

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